Rates of Return in the Property and Liability Insurance Industry: A Comparative Analysis

Abstract

This paper reports on a comprehensive study of the profitability of the P and L insurance industry undertaken as part of a general investigation of insurance prices and investment income. From a socio-economic point of view it compares risk and retums on invested capital with numerous other financial and nonfinancial sectors of the American economy. In measuring retum, all possible sources of income have been considered including unrealized capital gains as well as incomes attributable to the use of mixed cash/accrual accounting systems. risk/return comparisons are based on a 60-industry, 16-year econometric study. conclusions are based not on a sample but on industry aggregates, as well as on several measures of financial retum. No evidence of excessive return was found. These theoretical conclusions are examined against and verified by current industry experience. paper concludes with a plea for responsible academic treatment of this highly political and emotional subject. It urges the shunning of both the shibboleths and traditions of the industry as well as the cries and pressures of the consumerism movement. This paper has as its mission a comparison of the rates of return earned in Irving H. Plotkin, Ph.D., is Senior Economist for Arthur D. Little, Inc. This paper was presented at the 1968 Annual Meeting of A.R.I.A. During 1968, Dr. Plotkin spoke on the general subjects of Risk/Return and of Insurance Prices and Profits at the Executive Committee Meeting of N.A.I.C., Casualty Actuarial Society, British Executives and Press Conference (London), annual meeting of National Association of Independent Insurers, Operations Research Society of America, and the Sloan School Faculty Finance Seminar of M.I.T. Except for minor additions, this paper remains as written for and presented at the August 1968 Annual Meeting of the American Risk and Insurance Association. It draws on over two years of research into the economics of uncertainty. This research was undertaken with the aid of various colleagues in both the Department of Economics of the Massachusetts Institute of Technology and the Management Sciences Division of Arthur D. Little, Inc. present paper is in part based on the following papers and reports: Risk and Return in American Industry: An Econometric Analysis, Arthur D. Little, Inc., Cambridge. Mass.. May 1967. the property and liability insurance industry with the returns earned in numerCompetitive Problems in the Drug Industry; Statement before the Monopoly Subcommittee of the U.S. Senate Select Small Business Committee, Government Printing Office, Washington, D.C., December 19, 1967, pp. 1638-1666 and 1746-1784. Prices and Profits in the Property and Liability Insurance Summary Report, Arthur D. Little, Inc., Cambridge, Mass., November 1967. The Economics of the Property and Liability Insurance Industry, an address to the New York Society of Security Analysts, February 1968, reprinted in Wall Street Transcript, March 4, 1968, pp. 12584-12585. Risk/Return: U.S. Industry Pattern (with Gordon R. Conrad), Harvard Business Review, March-April 1968, pp. 90-99. Editor's Note: Since the publication of the Arthur D. Little Report and the presentation of the Plotkin paper, a number of researchers have presented critiques of this work. Dr. Long's comments appear following this article. Dr. Plotkin is presently preparing rejoinders to other reviewers-particularly Professors Hofflander and Mason and Professors Norgaard and Schick-for publication in subsenuent issues of this lournal.